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There was one major, galling exception. A new limited partner had put in $350,000 just before the 1973 to 1974 crash and panicked out at the bottom. For this partner more than half the funds vanished. Charlie could not talk the partner out of the decision to withdraw. "A lawyer is supposed to be an expert in persuasion, and I flunked a persuasion test that I think I should have passed," said Munger. "There was something in the mix of personalities, including a low pain threshold and a strong will in the limited partner, that somehow made me fail."
When dealing only with his own money, investment losses never bothered Munger much. To him it was like a losing night in a regular poker game where you knew you were one of the best players-you'd make up the difference later. But he now found that reported, temporary quotational losses in the Wheeler, Munger limited partnership accounts gave him tremendous pain. And so, by the end of 1974, he had resolved, like Buffett, to stop managing money for others in a limited partnership format. He would liquidate Wheeler, Munger after its asset value made a substantial recovery. And he would liquidate soon enough so that he would not take any general partner's override when the main investment positions were distributed.
In 1975, Wheeler, Munger did make an impressive recovery with a gain of 73.2 percent, and Munger and Marshall liquidated the partnership early in 1976. Even counting the dreadful times, during the 14 years Wheeler, Munger operated, the partnership turned in an average annual return of 24.3 percent before the general partners' override. (For a chart of the fund's performance, see page 251.)
"When the dust settled, my family had about $3 million from Wheeler, Munger and about $2 million more from real estate, and so on," said Munger. "It was a lot of money at that time, and it was a good time to have that much money. I owned wonderful securities, and other wonderful, bargain-priced securities were then available in the market."
When Wheeler, Munger was liquidated, the investors got securities in Blue Chip Stamps and Diversified Retailing, companies that later were folded into Berkshire Hathaway in stock swaps. Diversified Retailing, a company that was formed to buy one of the department store chains competing in the Baltimore metropolitan area, from the beginning had been mostly owned by the Buffett partnership, and by now was mostly owned by former members of the Buffett partnership. Wheeler, Munger owned 10 percent. The original purchase price was below the liquidating value of the business acquired, making it a classic Ben Graham type of play.
Diversified Retailing had borrowed about half the purchase price for the Baltimore acquisition, using a bank loan quickly replaced by longterm debentures that had almost no covenants limiting the borrower. Very soon thereafter, Buffett and Munger realized how intense Baltimore retailing competition was, and that they had made a mistake. They reversed course and sold the Baltimore department store chain for cash at almost no loss. The debentures were left in place offset by cash. Meanwhile Diversified Retailing had purchased for nearly nothing another chain of stores that threw off a profusion of cash. And so, during the great 1973 to 1974 stock market crash, Diversified Retailing had large amounts of investable assets, considerably more then twice what Buffett and Munger had paid for their original stockholdings. With stock prices at such a low level, it was a shopping spree in a bargain basement for Buffett and Munger. "It has been a source of satisfaction to me for decades that such a poor start was turned into a large success," said Munger. And again, shareholders who stuck with them were rewarded.
"We didn't know Diversified Retailing would become Berkshire," said Otis Booth. "I gave some shares [of Diversified] to the Los Angeles Natural History Museum. Over the years I had to beat on them hard to keep them. They kept two-thirds of the Berkshire that came out of it. They once had 1800 shares of Berkshire; they're now down to 1200." Though he doesn't always prevail in his recommendations, Booth still serves on the board of the museum.
Booth ended up with a 1.4 percent stake in Berkshire Hathaway, a little less than Munger's 1.5 percent holding-making him one of the largest investors in the company.' Other members of Munger's inner circle also prospered. Ed Hoskins, Munger's original partner in the electronics manufacturing business invested in Wheeler, Munger, and as a result, eventually ended up with some Berkshire Hathaway stock, as did Guerin, Marshall, Tolles, and, of course, Munger himself.
"The money in Berkshire Hathaway stock outperformed the rest," said Munger. "Little else could compound that way. As late as 1974, it was trading for $40 per share on shares now [in June of 2000] trading for $60,000." At times, Berkshire's price has reached more the $90,000. Munger's own cost basis for his Berkshire shares is less than $40, because he acquired them by swapping for stock that was purchased at a much lower price.
AT THE TIME OF WHEELER, MITNGER'S liquidation, limited partners among other things, got stock in New America Fund, which Munger and Guerin continued to operate until 1986 when the fund also was liquidated completely. As a small part of the New America Fund final liquidation, shareholders received stock in the Daily Journal Corporation.
BY THE TIME THIS PHASE of their careers was over, Charlie and Al Marshall had worked side by side in the same office for about two decades. The real estate projects amounted to a major deal for a young lawyer with a big family, and Munger says having good partners like Marshall was crucial to their success. "They were big things to take on," recalled Munger. "Buying Blue Chip Stamps with Guerin and Buffett was a big thing. All my life, I had high grade partners, some of the very best that could ever be. Even now that he is so famous, people underrate how fine a partner Buffett is. Jack Wheeler was great, even though he drank too much. A] Marshall was wonderful-worked hard on projects, made a big partnership contribution in pushing so hard for the purchase of See's Candy. I never had any flannel-mouthed baloney in the operation. I dealt with quality people."
During the 20 or so years they worked together, Al Marshall found himself having to pull Charlie out of all kinds of social messes. Every once in a while, said Marshall, Munger would go on a talking spree, and gab so long and rapidly that nobody was able to interrupt or change the subject. One evening at a dinner party, the host cornered Al and begged him to go in the other room and get Charlie, who had consumed several glasses of wine, to shut up. "Nobody can get a word in edgewise. He's lecturing them on difficulties religions have in describing heaven, something he called a thousand-year orgasm."
On top of that, Munger didn't mind turning up the heat when Marshall got into a little hot water. When the Mungers and the Marshalls were vacationing together at Nancy's parent's home on Oahu, the two couples were shopping in a grocery store. Al and his wife Martha were standing side-by-side at the meat counter picking out steaks for dinner when Martha Marshall stepped away to look at something else. A] didn't realize she was gone, and reached out and grabbed the rear end of some other woman. Al was startled to learn the buttocks were not those of his wife, and the victim was furious. Munger, who was at the other end of the meat counter shouted out, "You know, he does that to all the women." Charlie's comment only made the woman angrier.
Despite the jokes, Marshall said he learned a lot during the decades he worked with Munger. "I learned to make money," Marshall said. But additionally he came to believe that "Hard work, honesty, if you keep at it, will get you almost anything."
WHILE MANGER WAS GOING TIIROIUGH this period of enormous change, expansion, and development, his family sometimes were in a quandary when they tried to describe what Charlie did for a living. Molly Munger had trouble explaining her father to her friend Alice Ballard, a Philadelphia blue-blood and debutante. Alice had scored 800 on the verbal portion of the SAT and like Molly, attended Harvard Law School. To a California girl, Alice seemed worth impressing, but Charlie was of no help.
"My college roommate's father was a partner in an old-line Philadelphia firm. She was descended from William Penn. Charlie called on Fred Ballard (Alice's father), who later said, `I have no idea who [Munger] is from what he said of himself. He could be working for the CIA.' Daddy made
no coherent explanation of himself. He had this ratty little office in the stock exchange. What did he do-working in a ratty little office? And a fledgling law firm-he bought odd companies like K&W-the automotive chemicals company." Nevertheless, Molly's faith in her father was unshaken. "It didn't matter to me. It seemed like, `You just don't know him. If you don't know it now, you'll know it later. He's fabulous.'"
C H A P T E R T E N
BLUE CHIP
STAMPS
I've accused Father of being negative. He has a buoyant, cheerful upside, but also a negative side. He said, "No, no, I'm not negative. I jump like a little trout if it's a good idea." His hand went up in the air.
Molly Munger
IIARLES MIJNGLR, JR. KNEW SOMETHING was afoot in Munger's financial life when his father came to him to discuss a math problem. Charles, Jr. was studying to be a physicist and his math skills were advanced. The exercise involved a California company called Blue Chip Stamps, which had a pool of reserve funds to meet the obligation of redeeming stamps in the years ahead. It had a float account, similar to those used by insurance companies, to hold premiums for covering probable future losses-an account that is invested with investment returns accruing to the company. Each year a predictable number of Blue Chip Stamps were redeemed, causing a decline in funds, which in turn was offset by the proceeds of issuing stamps. What Munger really wanted to know was how fast Blue Chip's investable funds would decline under various scenarios.
Blue Chip Stamps had been in the news because of a dispute it had with a group mom and pop retailers who wanted to participate as owners of the company alongside big retailers who had founded it. At the time Rick Guerin was just recovering from his losses in the company sold to him by Jack Wheeler.
"Three years later, I got my capital back together, which was next to nothing, and Charlie and I talked a lot about investment ideas," said Guerin. "I'd react about Blue Chip Stamps in the newspaper, and I had an idea," Charlie said, 'I'll take you to my friend who knows more about float than anyone.'"
When Guerin was introduced to Warren Buffett, Rick realized, as he had when he first met Munger, that he was talking to someone exceptional. Rick was pleased when Buffett immediately saw the same potential value of Blue Chip's float that he had seen. Just by investing the float alone, the company could amount to something. Buffett, Munger, and Guerin slowly began accumulating shares, with Buffett buying the stock both for his personal account and for the Buffett Partnership.
Tracing the story of Blue Chip Stamps from its inception to the present is confusing, but it is central to understanding how Munger, Buffett, and Guerin became so rich, and how Berkshire Hathaway evolved into the company it is today. Blue Chip became the vehicle through which See's Candy, the Buffalo Neu's, and Wesco Financial were acquired, and these three companies later became essential to the cultural and financial foundation of Berkshire.
First, the history: An early precursor to frequent flyer miles in the 1950s and 1960s, trading stamps, such as Green Stamps, Blue and Gold, and Blue Chip, were handed out as a customer incentive by merchants. Retailers deposited money at Blue Chip in return for their stamps, then the money was used to operate the stamp company and to purchase the merchandise handed out when stamps were redeemed. Shoppers were given a certain number of stamps for each dollar spent in a store, which they pasted into books, then redeemed for prizes such as toddler toys, toasters, mixing howls, watches, and other items. Because it took time to accumulate enough stamps to redeem merchandise-and because some customers tossed the stamps in the back of a drawer, forgot them, and never did redeem them-the float built up. By the early 1970s, Blue Chip's sales amounted to approximately $120 million per year (around $400 million, in today's dollars). Its float at the time was nearly $100 million.
Stamps were popular with housewives and with merchants, who liked the increased sales and profits. One of the first trading stamp companies was S&H Green Stamps, but according to S&H's rules, only one type of retailer-a single grocery store, gasoline station, or drugstore-in each area could offer S&H stamps. A group of nine retailers, including Chevron Oil, Thrifty Drugs, and important California grocery chains, wanted the same competitive advantage, so they got together in 1956 and created Blue Chip Stamp Company. The Company was controlled by the nine retailers who organized it. Other store owners were allowed to offer the stamps, but they had no say in how the business was run nor did they share in the profits. Blue Chip became by far the largest trading stamp company in California and was so successful that eventually it faced a law suit from the small retailers who thought they weren't getting a fair shake from the founders. They claimed that the founding owners had violated antitrust laws by not providing ownership rights to small merchants.
In December 1963, the Department of justice filed an antitrust action against Blue Chip Stamp and the nine founding shareholders. After four years in court, a consent decree was entered in June 1967, calling for a complete reorganization of the company so that the founders could no longer exert complete control. Blue Chip Stamp Company then added an "s" to its name and became Blue Chip Stamps.
Under the court's decree, Blue Chip was required to offer approximately 621,600 shares of its common stock to the smaller, retail users of the stamps who previously were not shareholders. The shares were issued on a pro rata basis determined by the quantity of stamps given out by each of the nonstockholding retailers during a designated period. The offering consisted of three shares of common stock and a $100 debenture for a cash payment of $101. Any of the 621,600 shares not purchased by the nonstockholder users were to be sold on the open market. This new stock part of the offering amounted to 55 percent of the common stock of the company. To provide liquidity for old and new shareholders, the new Blue Chip shares were traded over-the-counter.
"Thousands of little retailers ended up with Blue Chip stock," said Buffett, and a market was born for the shares. "We saw this as a very cheap stock and bought aggressively. Charlie, Rick, and I ended up controlling Blue Chip."
They acquired their shares separately. "I started with $80,000," said Guerin, and built from there. Munger's investment matched Guerin's fairly closely.
"At Blue Chip Stamps, we finally took over the company. It was a friendly, gradual kind of takeover, but we took it over," said Munger.
By the early 1970s, Buffett's various entities had become Blue Chip's largest stockholder, Munger was the second largest and Guerin was somewhere behind. The three had accumulated enough shares to warrant positions on Blue Chip's board of directors.
"Blue Chip had an `old boys' board, some of whom resisted new guys, especially these smart-alecky young guys," said Guerin. "Charlie went on the board first, then convinced them they should accept me, and finally Warren was accepted."
Soon, their shareholdings in Blue Chip became densely tangled. In 1971, Warren and Susan Buffett personally owned 13 percent; Berkshire Hathaway Inc., of which the Buffetts were 36 percent owners, held 17 percent, and Diversified Retailing Co. Inc., of which the Buffetts owned 42 percent, held 16 percent. In addition, Diversified Retailing owned shares in Berkshire, and Munger's partnership owned 10 percent of Diversified Retailing, plus 8 percent of Blue Chip. Guerin's partnership also owned 5 percent of Blue Chip. Eventually, after more purchases of Blue Chip stock, the liquidation of Wheeler, Munger, and the merger of Diversified Retailing into Berkshire, Berkshire's ownership reached 60 percent. Together Berkshire, Buffett, and Munger owned nearly 75 percent of the outstanding shares of Blue Chip.
For some years, trading stamps continued to be Blue Chip's main business. In 1970, Blue Chip sales peaked at more than $124 million, but soon the popularity of trading stamps waned, and by 1982 sales plummeted down to $9 million. Sales amounted to only $200,000 a year by the late 1990s when Blue Chip's trading stamps were primarily issued by a few bowling alleys.
Buffett and Munger gained control of the investment committee once they were board members, and so during the time that trading stamps were sl
ipping from favor, the investment committee was at work building the value of Blue Chip's float.
Among the investments that Buffett and Munger acquired through Blue Chip was the largest block of troubled Source Capital, a closed-end investment company established in 1968 by the infamous "Go-Go" manager Fred Carr. Carr was a phenomenon for a while, but soon was discredited by the choppy stock market of the early 1970s. When Carr quit Source Capital, the fund had $18 per share in asset value, but was trading for $9. It was a situation much like that at the Fund of Letters, except that after Carr left, portfolio managers at Source Capital had considerable talent and a mind-set similar to that of Munger and Buffett. Blue Chip acquired 20 percent of the fund and Munger went on the board where he got along well with the main portfolio managers. Source Capital remained an independent company and is stilled listed on the New York Stock Exchange. Munger and Buffett referred a lot of management clients to Source Capital in subsequent years.
Most of Buffett's and Munger's acquisition attempts went smoothly, but they did not get all the properties they sought to acquire. In 1971, Blue Chip was outbid in an attempt to buy the Cincinnati Enquirer. The Enquirer at the time had a daily circulation of 190,000 and a Sunday circulation of 300,000. E.W. Scripps Co. was being forced to sell the newspaper to settle a U.S. Justice Department case charging it with having an illegal monopoly in the Cincinnati market. Blue Chip offered Scripps and its affiliate, Scripps-Howard, $29.2 million for the newspaper but was turned down. The Enquirer is now owned by the Gannett Company.
By 1980, Blue Chip had five areas of business: the remainder of its trading stamp business, See's Candy Shops, Wesco Financial, the Buffalo Evening News, and Precision Steel.
Along the way an uncomfortable incident involving Blue Chip's acquisition of Wesco Financial. The reaction of the Securities Exchange Commission caused Buffett and Munger to re-evaluate the way they were conducting their business.